Opinion: Here are the possible big surprises for investors in 2015

TimClift

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When it comes to financial markets, there are few absolutes. Even when consensus around upcoming scenarios approaches 100%, the unexpected will nevertheless occur from time to time. It’s these surprises that define the markets and test investors’ ability to remain focused and calm. As we begin a new year, now is the perfect time to reflect on the biggest surprises of 2014, and to prognosticate how our expectations may be upended in 2015.

Two biggest market surprises in 2014 were falling interest rates and collapsing oil prices. The first was a directional surprise — rather than interest rates slowly grinding up, as most investors expected, they dropped, driven mostly by a sluggish global economy and tumbling Eurobond yields. The second was a magnitude surprise — while many expected oil prices to drift down, thanks to a production boom in the U.S., almost no one predicted that they would be cut, roughly, in half.

Could the dollar drop?

When looking to 2015, we see the potential for both magnitude and directional surprises.

The first potential surprise is a weakening dollar, for one simple reason: The dollar was unstoppable in 2014, with the dollar index
DXY, +0.52%
surging more than 10%. This super-strength resulted from the divergence in monetary policies between the U.S. and almost all other countries last year, with the U.S. Federal Reserve looking at when to raise short-term interest rates while most other major economies were busy managing various forms of quantitative easing.

As we enter 2015, it looks likely that the Fed will raise short-term rates at some point, and Mario Draghi, president of the European Central Bank, is talking about additional easing.

A strengthening dollar, like rising interest rates a year ago, is currently the most popular view among investors. But think about this: At this same time last year, higher interest rates appeared to be a near certainty — and just the opposite happened. Now, it seems, a stronger dollar is a lock for 2015.

Tim Clift

True, it’s difficult to argue against a stronger dollar, but when everybody is on one side of a trade (buying) and no one is on the other (selling), activity can dry up and prices can move in unexpected directions. Plus, the dollar may have moved too far too fast — it ended 2014 up 12.8%, the largest annual gain in the past 17 years.

A double-digit gain in a currency within a year is highly unusual, and some ensuing giveback is quite possible.

Could inflation return?

Diversification won't benefit investors in 2015

(3:43)

Marketwatch's Chuck Jaffe explains why diversification may not help investors much this year. Photo: Getty.

The other potential surprise in 2015 is an overheating U.S. economy.

Right now, experts are fairly unanimous in expecting the U.S. to continue its slow and steady growth in 2015, despite a sluggish global economy and troubles around the world. The current consensus forecast for economic growth in 2015 is at a lukewarm level just below 3%. However, with a number of tailwinds in the U.S. economy, from lower energy costs to an improving job market, there is a distinct possibility that the U.S. economy could race ahead by 4% or even 5% — and that has the potential to lead to inflation, the stock market’s bogeyman.

Although an inflation scenario is more unlikely than a weaker dollar, the ramifications could be huge. While a much better-than-expected economy is generally good for society, this unexpected scenario could be a disaster for the financial markets.

The surprise of an overheating economy would most likely cause the Fed to raise short-term interest rates in a hurry. That could set off a panic repricing of loans across the board, and a significant repricing of stocks and bonds would likely ensue. Sound nasty? It would be.

Expect the unexpected

As we think about investing in 2015, it’s important to remember that no matter how strong your conviction about the shape of the future, there is no sure thing. While these two contrarian scenarios may not come true, there will certainly be other unexpected events that shake up the markets during the year.

It’s critical to think beyond the consensus and consider the possibility of surprises, even the improbable ones, when positioning portfolios for long-term success.

Tim Clift serves as chief investment strategist at Envestnet PMC and is responsible for the development of investment strategies for client portfolios and manager and fund-strategist selection methods.

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